Swiss Re Study Analyzes Rising Disaster Costs; Role of Risk Transfers

June 13, 2008

A new study from Swiss Re examines the rising impact of natural disasters, which is “driving up the cost of disaster relief and reconstruction for the public sector, especially in developing countries where insurance penetration is still low.”

The report – Disaster risk financing: reducing the burden on public budgets – “shows how recent risk transfer solutions offer governments, development banks and relief organizations models to access pre-event financing, and enable them to allocate relief funds more efficiently by using insurance and capital market instruments,” said the bulletin.

Swiss Re explained that the “impact of natural catastrophes on societies has increased considerably over the last two decades, driven by climate change, population growth and expanded economic activity. While average insured catastrophe losses between 1970 and 1989 were $8.3 billion per annum, these losses went up to $32 billion per annum between1990 and 2007.”

However, the reinsurer notes, in many cases, especially in developing countries, there is little if any insurance coverage to finance reconstruction. Out of a recorded total of 335 natural catastrophes in 2007, which caused overall economic losses of $64 billion across the globe, “$40 billion were uninsured. These losses had to be carried by individuals, companies and the public sector.”

In countries with less financial resources, a catastrophic event can result in higher deficits and debt for the public sector, which not only shoulders the cost of relief efforts, but is also responsible for rebuilding public infrastructure. As an example Swiss Re noted that the 1999 earthquake in Turkey “caused an economic loss of 11 percent of GDP. In 1986, an earthquake in El Salvador cost as much as 37 percent of GDP.”

A possible solution is to shift “from post-event to pre-event financing.” Reto Schnarwiler, Head of Swiss Re’s Public Sector Business Development, explained: “Risk avoidance and mitigation strategies must be the first priority in managing natural disasters. However, no organization or country can fully insulate itself against extreme events. Transferring catastrophic risk therefore has to be a key element in the financial strategy of every disaster-prone country or region in order to enable and sustain growth.”

Swiss Re’s latest focus report visualizes the significant value in shifting the traditional disaster relief approach – raising scarce funds after the event hits – to an approach that accumulates funds and funding sources before a disaster occurs.

Swiss Re advocates the creation of a “new generation of financial risk transfer solutions.” This would take the form of “sovereign insurance (or ‘macro-insurance’), instruments,” which can make it easier for governments to cope with disasters.

Should the scheme be widely adopted, “Governments will be able to deliver immediate relief to the victims of natural disasters without suddenly creating a significant burden on public finances,” says the report.

“One recent example of this approach is the GlobeCat securitization program designed by Swiss Re. Launched in December 2007, this solution uses financial instruments with an innovative trigger mechanism to transfer Central American earthquake risks to the capital markets. GlobeCat provides a payout based on the size of the population affected by a specific earthquake. For example, $1 million of donations or government funds can be used to secure contingent disaster relief funds in the amount of $45 million.”

Swiss Re also described a parallel program, consisting of “innovative micro-solutions,” which “can protect previously uninsured individuals and small enterprises from the catastrophic financial consequences of weather-related risks.”

It launched a “Climate Adaptation Development Program (CADP) in 2007 (See IJ web site – https://www.insurancejournal.com/news/international/2007/09/27/83759.htm). The goal is to provide financial protection against drought conditions for up to 400,000 people in Africa. “Based on climate risk indices, CADP will contribute towards developing a risk transfer market that will help smallholder farmers in Africa buy agricultural inputs, overcome a lack of collateral, draw upon agricultural extension services and accumulate income,” said Swiss Re.

Michel Li├Ęs, a Member of Swiss Re’s Executive Committee, concluded: “While governments, development banks or NGOs are constantly getting better at managing disasters more actively, they are finding it more and more difficult to address the financial implications of large-scale natural disasters. New forms of public-private partnerships allow them to leverage their funds through the use of insurance and capital market instruments.”

The full report and further information may be obtained on Swiss Re’s web site at: www.swissre.com.

Source: Swiss Re

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